Ed Zimmerman: Comp Negotiation Is Part of the Interview

ED ZIMMERMAN: Founders should pay themselves what they’re worth, but much of that will come as equity, at least in a startup’s early days, out of necessity. What a founder is worth will obviously also change with the fortunes of the company. The key issue is really whether he or she is in it for the long haul. Here are some points to consider when trying to arrive at founder compensation, plus tips for paying your earliest recruits:

1. Personal situation matters. If, for instance, you make a hefty annual income at a job you enjoy, foregoing both that income and the enjoyment that job provides would constitute a significant opportunity cost. Foregoing the same salary by giving up a job you dislike, however, constitutes a much lower opportunity cost. A founder may command a high price as a consultant or trader on Wall Street, but that doesn’t necessarily mean a 10- or 20-person startup would value those skills similarly and if the founder hates that Wall Street job, he or she may not value the Wall Street income potential too much either. Hopefully, a highly compensated founder is going to derive much more satisfaction from the new endeavor and that is supposed to bridge the cash compensation gap, especially in the early days. If not, then don’t quit that day job!

On a related note, “covering the nut” matters, too. Some founders start wealthy, some with nothing and many are in the middle. A founder with a mortgage and family to support, for instance, may need more base compensation than a young single, and that could toggle the equity situation as there’s a dynamic interplay between cash compensation and equity.

2. CEOs don’t have to be the highest earners. I happen to be teaching the Harvard Business School case study “Founder-CEO Succession at Wily Technology” right now in my VC and angel-investing class at Columbia Business School. In it, the CEO points out: “I even agreed to pay them more than I paid myself as CEO.” There’s no rule that CEOs must outearn others in the company. Certainly, asking people to sacrifice by making below-market salaries is easier when the CEO has the moral authority that comes from under-earning her or his senior executives. I’m not saying founders must do it, but it is important to keep in mind the relationship between CEO comp and the amounts paid to others in the company. Similarly, in my role as company counsel to many VC-backed startups, I suggest that founders also avail themselves of that same moral authority by signing up for the same vesting schedule/duration, drag along and restrictive covenants they will be asking their senior executives to sign. (I explained vesting and drags in an earlier WSJ Accelerators column). Alignment and transparency pay off.

3. Define the unique character of your culture. Startups must often compete for employees against far better-capitalized companies with greater cachet. In a hot market, certain types of professionals — engineers, for example — can command very high salaries. As a startup, you are selling something different.

Years ago, I had a conversation with a recruiter who was trying to lure me elsewhere. I explained how kindly people here at Lowenstein Sandler had treated me when, as a very junior associate, I took time off to be at my father’s bedside as he was dying of cancer. I also explained how co-workers had mentored me, and how many are also the people I turn to when I want to share joys and sadness. The recruiter said, “I guess you can’t put a price on that.” I replied, “I think I just did! I’m passing on the opportunity, but thanks anyway.”

The point is, a great work culture is valuable. Understand what you have to sell, what kind of culture you want to build, and what people are willing to do for and about it. If, for instance, you want to start a company in a remote location, you need to be able to articulate why that is a selling point (rather than how to overcome it) and how it factors into the total package you offer people. At the most senior levels, nobody worth hiring will take a job solely due to the cash and stock. Job seekers ought to want to be a part of something larger than themselves and it has to be something of which they can be proud.

4. Compensation negotiations can be a proxy for character. When advising clients or evaluating executives, I often use compensation negotiations as part of the evaluation process. The best hires I’ve seen have had very quick and easy compensation negotiations. Usually, they want to know that their upside is wide open. Often they’re frank about their needs and what they had been making. This may not always be true, but someone who over-negotiates their comp package is likely to be a little more difficult to have on the team more generally. Compensation negotiation is part of the job interview.

I represented a venture-backed tech company in the late 1990s in which one senior engineer so thoroughly over-negotiated his comp package during the venture round that he soured the management team on his future at the company. He never did last. We took that company IPO and then did a follow-on offering. I’ve often thought about the eight digits of cash that engineer would have had if he hadn’t overplayed his hand. A cautionary tale indeed.

About The Accelerators

For aspiring or actual entrepreneurs, The Accelerators is an online archive of discussion among startup mentors– entrepreneurs, angel investors and venture capitalists. Although the blog is no longer being updated, its content lives here and you can see an archive of its tweets through June 2015 @wsjstartup.